From accounting periods beginning on or after 1 April 2024, most payments to overseas subcontractors and externally provided workers (EPWs) no longer qualify for UK R&D tax relief, with only narrow exceptions. This is one of the most significant practical changes in the reformed R&D regime and is already forcing groups with offshore development centres or labs to rethink how and where they structure R&D activity.
Why the rules have changed
The government’s stated policy aim is to refocus the incentive on R&D that is physically carried out in the UK and to ensure that the scheme delivers maximum benefit to the domestic science and technology workforce. Under the old SME and RDEC schemes there was no general prohibition on claiming relief for overseas subcontractor and EPW costs, which meant a significant share of subsidised R&D was being undertaken outside the UK.
As part of the move to the merged RDEC style regime and Enhanced R&D Intensive Support (ERIS), new “overseas restrictions” were legislated so that, by default, only work done in the UK or by workers on the UK payroll can qualify where third parties are involved.
What has changed in practice?
For accounting periods beginning on or after 1 April 2024, a general ban applies to most overseas third party R&D costs. In particular:
Payments to overseas subcontractors for R&D work are normally not qualifying expenditure. It is the location of the R&D activity that matters – if the work is carried out overseas, the cost is generally excluded.
Payments for EPWs supplied by an overseas provider are only qualifying if the EPW’s earnings are subject to UK PAYE and Class 1 NICs; otherwise, they fall within the overseas restriction.
These rules apply to both the merged RDEC style scheme and ERIS, so loss making R&D intensive SMEs are not exempt from the overseas restrictions.
Importantly, in house staff on your own UK payroll are not affected by the restriction, even if they travel and carry out some R&D activities abroad; it is their PAYE position, not their physical location, that controls the treatment.
Which businesses are most affected?
Any company that has historically relied on offshore delivery is exposed to the new rules. This includes:
Tech companies using development houses in Eastern Europe, India or other low cost locations for software build, testing or maintenance.
Manufacturing and engineering businesses that subcontract prototyping or testing to overseas facilities for reasons of capacity, cost or existing relationships.
Groups with central R&D hubs outside the UK, where the UK entity currently contracts and recharges activity but the substantive work is performed overseas.
For these models, a large portion of previously claimable spend on subcontractors and EPWs may now be excluded, unless the work falls within the narrow statutory exceptions described below.
The three part legal test for exceptions
Parliament recognised that, in some cases, it is genuinely impossible or unreasonable to perform R&D in the UK, so the legislation allows overseas costs to qualify if a strict three limb test in CTA 2009 s1138A(2) is met. All three conditions must be satisfied:
1. Necessary conditions for the R&D are not present in the UK.
2. Those conditions are present in the overseas location where the R&D is undertaken.
3. It would be wholly unreasonable for the company to replicate those conditions in the UK.
HMRC’s Corporate Intangibles Research and Development (CIRD) Manual confirms that this is a fact specific test and that the term “conditions” is deliberately broad, going beyond purely physical factors. The onus is on the company to evidence why each limb is met for the particular project and activity.
Valid conditions: environment and regulation
HMRC’s guidance groups valid “conditions” into two broad categories, though this list is not exhaustive.
Geographical, environmental or social conditions:
These are real world features that simply do not exist in the UK, such as a desert climate, tropical disease prevalence, specific flora or fauna, deep sea environments or particular geological formations. For example, field trials on desert resistant crops or deep sea organisms in environments that the UK does not possess may justify overseas R&D costs.
Legal or regulatory requirements:
These arise where laws, regulations or binding regulatory expectations require the R&D to take place in a specific jurisdiction. Examples include clinical trials that a foreign medicines regulator insists must occur within its territory, or mandatory on site testing in a particular country before products can be approved or exported.
HMRC stresses that conditions may fall under one or both categories, or potentially neither, provided they genuinely satisfy the three part test; what matters is the substance of the constraint, not the label.
What does not count as a condition?
The legislation is equally clear about what cannot be used to justify overseas R&D. CTA 2009 s1138A(3)(b) explicitly excludes two factors from being “conditions”:
The cost of the R&D activity
The availability of workers to carry out the R&D activity.
HMRC’s manual explains that if the main or only reason for placing the R&D overseas is that it is cheaper, or that suitably skilled workers cannot easily be recruited in the UK, the overseas expenditure will not qualify, even if the commercial case for offshoring is compelling. Cost and staff availability can be part of the overall picture, but they cannot be the decisive conditions absent in the UK for the purposes of the statutory test.
Common real world scenarios
The new rules play out differently across business models. A few common scenarios illustrate the impact.
Offshore software development
Many UK tech companies use overseas teams for coding, testing and maintenance because labour is cheaper or particular skills are more readily available. In most cases these reasons relate to cost and worker availability, which are specifically excluded as valid conditions, so payments to those overseas contractors will not be qualifying expenditure under the merged scheme or ERIS.
Where some activities are split between UK and overseas teams, HMRC expects companies to understand their supply chain and apportion contractor payments on a just and reasonable basis, claiming only the UK element.
Clinical trials overseas
Life sciences and med tech businesses frequently run trials in countries where a disease is prevalent, or where a local regulator demands in country evidence as part of licensing. In such cases there may be both environmental (disease only present overseas) and legal/regulatory conditions that are not present in the UK and would be wholly unreasonable to replicate domestically, especially where large scale patient populations or specific hospital networks are required.
Here, overseas subcontractor or EPW costs can potentially qualify, provided the company can demonstrate how each limb of the statutory test is met and retain contemporaneous evidence to support that position.
Product testing in unique environments
Engineering and manufacturing groups might need to test products in climatic or physical conditions the UK cannot provide, such as desert heat, high altitude, tropical humidity or certain marine environments. Where those conditions are genuinely unavailable in the UK and would be wholly unreasonable to replicate (for example, by building a large dedicated facility that would see minimal use), overseas R&D testing may get through the exception.
Again, the burden is on the claimant to show why UK based testing was not realistically possible and why the chosen overseas environment was necessary for resolving the technological uncertainties in question.
Evidence and documentation expectations
Although companies are not required to submit evidence of location and PAYE status upfront with their R&D claim or Additional Information Form, HMRC expects claimants to have a clear understanding of where R&D work takes place and on what basis they have treated costs as UK or overseas. Guidance indicates that:
For contractors, claimants should be able to explain where activities were performed and, where mixed, how payments were apportioned between UK and overseas work.
For EPWs, claimants must be able to show that the workers’ earnings were subject to UK PAYE and Class 1 NICs where they have treated costs as qualifying despite some activity being done abroad.
Professional commentary also stresses the importance of keeping project level records explaining why any overseas R&D is said to meet the s1138A exception, including board papers, regulatory correspondence, scientific rationales and contemporaneous notes of decision making.
Practical steps for businesses
Companies that use overseas resource for R&D should not wait until filing time to address these changes. Key actions include:
Map your R&D supply chain
Identify which parts of each project are done in the UK and which overseas, and whether those overseas activities involve subcontractors or non PAYE EPWs caught by the new rules.
Reassess contracts and structures
Consider whether some work can be re shored to UK teams or restructured so that UK based staff lead core R&D while overseas providers handle routine, non R&D tasks.
Identify potential exception cases early
Where overseas activity might genuinely meet the environmental or regulatory test, build the evidential file as you go rather than retrospectively.
Update internal policies and training
Ensure finance, tax and project teams understand that cost and skills availability alone are not enough to justify claiming overseas R&D expenditure under the new regime.
Final thoughts on UK R&D Overseas Expenditure Rules
The overseas expenditure rules mark a deliberate shift towards rewarding R&D that is substantively performed in the UK, while leaving only a narrow gateway for genuinely unavoidable overseas activity. For groups with offshore development centres, international CRO relationships or global testing programmes, the change can materially reduce claim values unless R&D footprints and contractual arrangements are actively redesigned.
Handled well, a careful review of projects, supply chains and evidence can preserve relief where valid exceptions apply and reduce enquiry risk where it does not; handled passively, businesses risk either over claiming and facing challenge, or under claiming and leaving money on the table.
Claiming with overseas costs?
With major changes to overseas expenditure rules taking effect from April 2024, don't leave your R&D claim to chance. Get expert clarity on what costs now qualify and ensure your claim stands up to HMRC scrutiny.
